INTRODUCTION

A form of cryptocurrency called stablecoins is designed to provide greater stability than other cryptocurrencies. Some are really backed by a reserve of the asset they stand in for, while others utilize algorithms or other techniques to prevent too much volatility in their prices. A method of bridging the gap between fiat currencies like the U.S. dollar and cryptocurrencies is provided by stablecoins. 

Stablecoins are a creative response to the volatility of cryptocurrencies since they are price-stable digital assets that act somewhat like money but retain the portability and utility of cryptocurrencies. Price stability is inherent in the assets themselves.

Fiat-backed, crypto-backed, commodity-backed, and algorithmic stablecoins are the four main categories, which can be distinguished by the underlying collateral structure. Stablecoins have gained popularity since the first one was released in 2014 because they provide the speed and security of a blockchain without the volatility that most cryptocurrencies experience.

Due to their intrinsic stability, stablecoins are good value stores and are more likely to be used in everyday transactions. The mobility of cryptocurrency assets within the ecosystem is also boosted by stablecoins.

Owners of stablecoins and fiat currencies are aware that their assets’ purchasing power can be utilized to pay for goods and services and won’t fluctuate over short time periods.

Most stablecoins have their value linked to the price of either a specific fiat currency, like the US dollar, or a specific commodity, like gold. Since they are linked to the U.S. dollar, stablecoins that track it should have a set value of $1.

This peg can be kept in place using a variety of methods. Asset backing is the approach taken by stablecoins the most frequently. Asset backing is the ratio of the total stablecoin tokens in circulation to the total assets backing it. If there are assets worth the same amount supporting each stablecoin that is in circulation, then the stablecoin is said to be backed 1:1.

Due to their intrinsic stability, stablecoins are good value stores and are more likely to be used in everyday transactions. The mobility of cryptocurrency assets within the ecosystem is also boosted by stablecoins.

Owners of stablecoins and fiat currencies are aware that their assets’ purchasing power can be utilized to pay for goods and services and won’t fluctuate over short time periods. As previously said, stablecoins distinguish themselves by being based on the blockchain.

THE TYPES OF STABLECOIN

There are three types/categories of stablecoin: 

• Fiat-Collateralized Coins,
• Crypto-Collateralized Coins, 
• Algorithmic Coins. 

• Fiat-Collateralized Coins

The majority of stablecoins in this class are backed by fiat money, but they can also be backed by real assets like gold or oil. Popular examples of coins with a dollar value per coin include USDT and TrueUSD (Opens in a new window). Fiat-collateralized coins are expected to be audited on a regular basis, have reserves to support their supply, and are kept by independent financial institutions that serve as custodians. Unfortunately, it doesn’t always occur, and some stablecoin producers have come under fire for keeping losses from their clients 

• Crypto-Collateralized Coins

Coins that have been collateralized with other digital currencies are known as cryptocollateralized coins. However, that naturally makes things less stable, thus these currencies typically have a larger reserve on hand. According to Investopedia (Opens in a new window), $2,000 worth of cryptocurrency may be held in reserve for each $1,000 worth of stablecoins to account for price fluctuations of up to 50%. DAI (DAIUSD)(Opens in a new window), a cryptocurrency-collateralized token backed by Ethereum, is now worth around $1 per coin.

• Algorithmic Coins

Computer programs are used by algorithmic currencies to preserve stability. For instance, the stablecoins programming would be designed to track the value of the US dollar and alter the value of an algorithmic coin to reflect the current exchange rate if it were linked to the value of the US dollar. The quantity of coins in circulation would subsequently be adjusted in accordance with the coin’s value. Sounds nice, but it can be overstated.

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INVESTING IN STABLECOINS: DOES IT WORTH IT

Most cryptocurrencies lack the stability necessary to be used as genuine money, however stablecoins make up for some of this deficiency. However, users who use stablecoins should be aware of the hazards involved. While stablecoins may appear to have minimal dangers during most times, they might also become the biggest gamble during times of crisis.

Stablecoins do not change as much as traditional crypto coins because they are backed by national currencies, which reduces price and volatility. They also share additional benefits with other crypto coins such as the lack of intermediaries, transaction anonymity, rapid transfers, and blockchain security. Among other things, they can be used to pay for groceries, transportation, or utility expenses.

Many times, smart contracts are built on top of other cryptocurrencies like Ethereum. The conditions of the contract may be unpredictablely affected by frequent price adjustments. By lowering market volatility and guaranteeing that more secure contracts are upheld by the blockchain, the usage of stablecoins like Tether can offer contract stability to both parties.

Additionally, the majority of stablecoins are subject to an independent audit to confirm that the crypto-assets they claim to be backed by are in fact present. Having the confidence that they can swap their assets back into fiat currency at a set exchange rate gives people who use stablecoins frequently an additional layer of financial protection.

In the cryptocurrency world, stablecoins are a specialized form of currency that are not good investments. They are more appropriate for virtual exchanges and the conversion of virtual assets into and out of “real” money.

CHALLENGES AND RISKS INVOLVE WITH STABLECOIN

According to Anthony Citrano, founder of a NFTs marketplace Acquicent, “The primary risk of stablecoins is that they aren’t fully backed by the reserve currencies they say they are,” Stablecoins could appear to be low risk at first glance. They are compared to well-known cryptocurrencies that have no backing. However, stablecoins come with certain standard crypto dangers as well as at least one unique risk.

Stablecoins must be stored someplace, whether it’s in your own digital wallet, with a broker, or on an exchange, just like other cryptocurrencies. And that creates dangers since a certain trading platform might not be secure enough or might have some flaws.

By relying on a third party to issue money and maintain the stability of a cryptocurrency, the dollars may only be partially reserved rather than fully backed. In this scenario, a bank run may cause the price of the coin to plummet sharply.

Stablecoin may experience a run and lose the peg to its target currency if it is not sufficiently supported by hard assets, notably cash. Since it wasn’t backed by cash but rather other cryptocurrencies in May 2022, that is essentially what occurred to the algorithmic stablecoin TerraUSD. As traders lost faith in the stablecoin’s capacity to uphold the peg, its price collapsed and started to fall.

There is a chance that the mechanism that maintains the currency’s stability will fail because the majority of decentralized stablecoins reside behind smart contracts in protocols like Ethereum or Stellar. Even a third party could alter an algorithm. Updates to the network may affect earlier smart contracts because “code is law,” which is a major hassle for decentralized projects.

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